ABOUT SEAN STANNARD-STOCKTON

Sean Stannard-Stockton is the president and chief investment officer of Ensemble Capital Management, located in Burlingame, CA, midway between San Francisco and Silicon Valley. From 2006 through 2012, Sean authored the Tactical Philanthropy blog and wrote regular philanthropy columns for both the Financial Times and the Chronicle of Philanthropy. In 2012, Sean officially ended the blog to focus on growing Ensemble Capital.

Day 2 of the Tactical Philanthropy track at the 2010 Social Capital Markets Conference (SOCAP10) began with a packed room eager to learn about behavioral finance and how it might influence impact investing. It also marked the first session to address the “Money for Good” report (PDF) issued by Hope Consulting in May; surprisingly, none of the previous day’s session had mentioned it. The panel discussion featured Randy Allison Hustvedt of Federal Street Advisors and Hope Neighbor of Hope Consulting. It was moderated by Rae Richman of Rockefeller Philanthropy Advisors.

As the moderator, Rae prefaced the discussion by noting that an understanding of behavioral finance will help funders and donors understand how to better embrace the concept of impact investing, which remains a somewhat foreign concept in the philanthropic community. Randy then helped the audience by defining behavioral finance, which looks at both the rational and irrational behavior of people.

At its core, behavioral finance stipulates that market participants do not always make rational financial decisions. This definition flies in the face of the efficient market hypothesis most of use learned in economic classes. That theory asserts that as a practical matter, the major financial markets reflect all relevant information at a given time and that people act rationally at all time. Realistically, though, people do not make rational finance decisions consistently.

To illuminate the behavioral finance approach, Randy took the audience through several exercises that tested the rational behavior of the participants. The first exercise underscored the “endowment effect”, in which an individual attaches a higher value to a product or service than another person who may not have the same emotional connection to that product or service. The second exercise highlighted how people often make inconsistent choices when presented with the same data but from different frames of reference. The manner in which a problem is framed to a person – such as applying positive or negative filters – will generate different behaviors even when the problem is the same in both scenarios.

The last example used a hypothetical scenario to demonstrate how people tend to make irrational finance decisions. In this example, audience members had bought shares in Coca Cola a year ago for $35 per share and also bought shares in Pepsi for $5 per share. Both stocks were now worth $20 per share. A month from now, both stocks will decline to $15 per share. Coincidentally, the audience would also need to sell stock in order to raise $15 of capital. Randy asked the audience which stock it would sell to raise those funds.

In this exercise, the audience generally decides to sell Pepsi shares since it represents ‘earned’ money (we did buy it at $5 per share, so we’re still making a profit of $10; selling Coca Cola shares would have locked us in for a $20 loss). That decision, though, epitomizes behavior finance and the irrational decisions people make.

The rational finance decision would have actually been to focus on which stock has the better earning potential in the long term and to sell the other product – either Coca Cola or Pepsi depending on the research. Randy noted that these behavior decisions often transpire in philanthropy – donors will make different decisions based on the limited information, emotional attachments, or in reaction to how problems are presented to them. As we look to apply the conclusions of the Money for Good report and build impact investment opportunities, we need to take those behavior approaches into account.

The session then shifted to Hope Neighbor and the Money for Good report. The nationwide survey conducted for the report collected responses from 4,000 individuals with household incomes greater than $80,000 and oversampled for individuals with household incomes greater than $300,000. There are many important findings from the report with implications for philanthropy. In the context of behavioral finance, the study assessed peoples actions instead of their preferences by forcing them to consider trade-offs.

The report concludes that there is a $120 billion market opportunity for impact investing with over half of potential individual investors interested in making investments of $25,000 or less. Potential investors cite barriers to making impact investments, but the major barriers identified in the Money for Good report reflect the fact that this is a new investment product. Importantly, these investors are also much more open to impact investment when it is not positioned as an alternative to charitable giving.

It also includes three major findings reflective of behavioral finance. First, people are very interested in impact investing and willing to invest more in impact investing than charitable giving. Two, as impact investors, people care more avoiding loss in their investments than generating higher returns; their priority is to get their principal investment back.

Last, people continue to engage in mental accounting in which they compartmentalize their allocation of financial resources into different buckets. The supposition going into the study was that people should make charitable giving and impact investing decisions in a similar fashion. But, the Money for Good report found that there is not a single social capital market – donors think of impact investing and charitable giving as separate approaches. The social capital market is young as a concept and still in its formative stage. However, we need to address needs of individual investors in order effectively build the impact investment market.

Following the crash course in behavior finance, Rae began a discussion with the panel on how to apply it to build donor and institutional interest in impact investing. Both Randy and Hope stressed the importance of communication and positive framing. While impact investing sometimes originates from donors already engaged in philanthropy who are looking at other investment possibilities, there is still a tremendous need for advisors and supporters to suggest this as an additional approach. Hope noted that people get into philanthropy for self actualization; that same fundamental approach underscores impact investment behavior.

The panel discussion then tackled the ongoing debate about measures, metrics, and impact assessment and the implications for impact investing. Specifically, Rae asked the speakers to discuss the social and environment metrics that go along with the finance metrics. Randy responded that impact investments that include social returns on investments are somewhat more accepted that the efforts to capture social impact through charitable giving. Hope expects that metrics will become even more important as both impact investors look for information to justify their investments and as financial advisors promote impact investing as an option. She also stressed the opportunity to get donors to use information to better inform their decisions – for example, while 85% of the Money for Good respondents care about nonprofit performance, only 32% conducted research on the charity prior to giving and only 3% would use comparative data to make decisions on where to donate.

Audience questions focused on potential differences between individuals and foundations interested in engaging in impact investments as well as the need for a shared vocabulary that can bridge charitable giving and social impact investing. The panel’s responses again highlighted the need for better communication. Positioning impact investing as an option for donor and institutions will require additional education and support of individual donors and leaders within institutions. To that end, resources such as Global Impact Investing Network, PRI Makers, and the Take Action! Impact Investing Conference series offer additional educational resources on the currently fragmented approaches to impact investing.

The conclusion of the session highlighted to me the nascent state of adopting impact investing. The philanthropic and social impact investment sectors do not share a common vocabulary yet, as noted by the audience and the panel. The lack of a common understanding and vocabulary to explain and push forward this field will evolve over time, but we now wrestle with an alphabet soup of terminologies that needs to be aligned both within impact investments and with the philanthropic sector. Nor do we have a clear sense on how to best position or support donors and institutions looking to engage in both charitable giving and impact investing.

However (and the most important takeaway for me from this intense session), we are collectively in a unique moment in the evolution of philanthropy and face both tremendous opportunities to reshape the landscape as well as a lot of ambiguity on the right approaches. This is a tremendous opportunity to shape how we allocate financial resources in the future to better society. We cannot sit on the sidelines and watch it roll by us.

As Randy and Hope noted, we are now at the intersection of the two worlds and are trying to maximize both. Fundamentally, we need to meet people where they are instead of trying to push them into new areas. A gentle introduction to new charitable and investment approaches could eventually generate additional giving and impact investments that tap into the market opportunities highlighted in the Money for Good report.